In Brief

The valuation of Chinese innovators is many times higher than their Western counterparts

By Kai-Fu Lee and Jonathan Woetzel.

China has firmly established itself as a global leader in consumer-oriented digital technologies. It is the world’s largest e-commerce market, accounting for more than 40% of global transactions, and ranks among the top three countries for venture capital investment in autonomous vehicles, 3D printing, robotics, drones and artificial intelligence (AI). One in three of the world’s unicorns (start-ups valued at more than US$1 billion) is Chinese, and the country’s cloud providers hold the world record for computing efficiency. While China runs a trade deficit in services overall, lately it has run a trade surplus in digital services of up to $15 billion per year.

Powering China’s impressive progress in the digital economy are Internet
giants like Alibaba, Baidu and Tencent, which are commercialising their
services on a massive scale and bringing new business models to the world.
Together, these three companies have 500-900 million active monthly users in
their respective sectors. Their rise has been facilitated by light – or,
perhaps more accurate, late – regulation. For example, regulators put a cap on
the value of online money transfers a full 11 years after Alipay introduced the
service.

The digital
ecosystem

Now these Internet firms are using their positions to invest in China’s
digital ecosystem – and in the emerging cadre of tenacious entrepreneurs that
increasingly define it. Alibaba, Baidu and Tencent together fund 30% of China’s
top start-ups, such as Didi Chuxing (valued at US$50 billion), Meituan-Dianping
(US$30 billion), and JD.com (US$56 billion).

With the world’s largest domestic market and plentiful venture capital,
China’s old “copycat” entrepreneurs have transformed themselves into innovation
powerhouses. They fought like gladiators in the world’s most competitive
market, learned to develop sophisticated business models (such as Taobao’s
freemium model), and built impregnable moats to protect their businesses (for
example, Meituan-Dianping created an end-to-end food app, including delivery).

China a world
leader

As a result, the valuation of Chinese innovators is many times higher
than that of their Western counterparts. Moreover, China leads the world in
some sectors, from livestreaming (one example is Musical.ly, a lip-syncing and
video-sharing app) to bicycle sharing (Mobike and Ofo exceed 50 million rides
per day in China, and are now expanding abroad).

Most importantly, China is at the frontier of mobile payments, with more
than 600 million Chinese mobile users able to conduct peer-to-peer transactions
with nearly no fees. China’s mobile-payment infrastructure – which already
handles far more transactions than the third-party mobile-payment market in the
United States – will become a platform for many more innovations.

As Chinese firms become increasingly technically capable, the country’s
market advantage is turning into a data advantage – critical to support the
development of AI. The Chinese firm Face++ recently raised $460 million, the
largest amount ever for an AI company. DJI (a $14 billion consumer drone
company), iFlyTek (a $14 billion voice recognition company), and Hikvision (a
$50 billion video-surveillance company) are the world’s most valuable firms in
their respective domains.

Another important developing trend in China is “online merging with offline” (OMO) – a trend that, along with AI, Sinovation Ventures is betting on. The physical world becomes digitised, with companies detecting a person’s location, movements, and identity, and then transmits the data so it can help shape online experiences.

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For example, OMO stores will be equipped with sensors that can identify
customers and discern their likely behaviour as seamlessly as e-commerce
websites do now. Similarly, OMO language learning will combine native teachers
lecturing remotely, local assistants keeping the atmosphere fun, autonomous software
correcting pronunciation and autonomous hardware grading homework and tests.
With China in a position to rebuild its offline infrastructure, it can secure a
leading position in OMO.

Yet, even as China leads the way in digitising consumer industries,
business adoption of digital technologies has lagged. This may be about to
change. New McKinsey Global Institute research finds that three digital forces
– disintermediation (cutting out the middle man), disaggregation (separating
processes into component parts), and dematerialisation (shifting from physical
to electronic form) – could account for (or create) 10-45% of the industry
revenue pool by 2030.

Those actors that successfully capitalise on this shift are likely to be
large enough to influence the global digital landscape, inspiring digital
entrepreneurs far beyond China’s borders. Value will shift from slow-moving
incumbents to nimble digital attackers, armed with new business models, and
from one part of the value chain to another. Large-scale creative destruction
will root out inefficiencies and vault China to a new echelon of global
competitiveness.

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Big plans for
a big future

China’s government has grand plans for the country’s future as a digital
world power. The State Council-led Mass Entrepreneurship and Innovation Program
has resulted in more than 8,000 incubators and accelerators. The government’s
Guiding Fund program has provided a total of US$27.4 billion to venture capital
and private equity investors – a passive investment, but with special
redemption incentives. The authorities are now mobilising resources to invest US$180
billion in building China’s 5G mobile network over the next seven years and are
supporting the development of quantum technology.

The State Council has also issued guidelines for developing AI
technologies, with the goal of making China a global AI innovation centre by
2030. Xiongan, now under construction, may be the first “smart city” designed
for autonomous vehicles. In Guangdong Province, the government has set an
ambitious target of 80% automation by 2020.

Such aspirations will inevitably disrupt the labour market, beginning
with routine white-collar jobs (such as customer service and telemarketing),
followed by routine blue-collar jobs (such as assembly line work), and finally
affecting some non-routine jobs (such as driving or even radiology). Recent MGI
research found that in a rapid-automation scenario, some 82-102 million Chinese
workers would need to switch jobs.

Displaced
workers

Retraining the displaced will be a major challenge for China’s government,
as will preventing major digital players from securing innovation-stifling
monopolies. But the government’s readiness to embrace the emerging digital age,
pursuing supportive policies and avoiding excessive regulation, has already
placed the country at a significant advantage.

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Kai-Fu Lee is a co-founder and CEO of Sinovation Ventures, a leading
venture capital firm investing in China and North America. Jonathan Woetzel is
a McKinsey senior partner, a director of the McKinsey Global Institute, and
co-author of No Ordinary Disruption: The
Four Global Forces Breaking All the Trends.